#Token Mania
The new funding mechanism using distributed ledger technology that displaces both public markets (IPOs) and private investment (Venture Capital) with a billion of USD equivalent cryptocurrency Suitable only for professional investors
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Table of Contents Lex Sokolin Partner & Global Director Fintech Strategy
I.
Introduction to Initial Coin Offerings
II.
ICO Market
@autonofintech
[email protected] July 2017
III. Sources of Capital IV. Strategic Context and Direction V.
Regulatory and Governance Issues
VI. Investment Structure Considerations VII. About Autonomous VIII. Appendix
Key takeaways across industry players Startups/Ecosystem
Investors
• Key regulatory and governance questions inhibit the flow of mainstream capital and adoption, so resolve these issues with transparency and standards
• Although the current ICO market has the symptoms of a bubble, there is an underlying innovation that has the attributes of a massive platform shift in the digital world
• Focus on delivering functional innovations that solve tractable problems in the economy for the mainstream, in addition to the technical infrastructure for smart contracts and processing
• Leverage lessons of the Dotcom years -- while most projects fail, some will redefine their industries in a winner-take-all dynamic over a 10+ year holding period
Financial Incumbents • Understand causes of the ICO wave and its technology; consider geopolitical forces challenging sovereigns and incumbents across the world – from automation to loss of trust and to decentralization • Build financial capabilities around Crypto tokens as an asset class, from research to custody to exchanges, leveraging regulatory capability as advantage
• Treat building the ecosystem as a marathon with long-term value creation, rather than taking advantage of ICOs for fast funding
• Manage exposures appropriately; in a core/satellite asset allocation, Crypto tokens should be a subset of Alternatives, likely no more than 5% of the overall portfolio
• Find ways to partner with incumbents in your industry to translate value from the Crypto economy to the physical world
• Diversification within Crypto token holdings is also important, evidenced by quick turnover in Altcoins rankings in last 4 years
• Extend Corporate Venture Capital to engage with the developing ecosystem at the right risk level
• Make UX/UI more intuitive to the average consumer for broader adoption and understanding
• Cyber security of wallets and exchanges must be managed, as well as possibilities of scams
• Find ways to translate economic activity occurring in digital worlds to the traditional economy
• Consider using Crypto tokens as an operating strategy, such as tokenizing internal currencies and workflows, or catalyzing developer communities around open APIs
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A Note on Terminology – ICO or Token Launch? • Participants in the ecosystem refer to the distribution of tokens as part of a decentralized blockchain project in a variety of ways
Google Search Trends Delta on an Absolute Basis (Last 5 years)
• The media and many speculators primarily use the term ICO (“Initial Coin Offering”) or, sometimes, ITO (“Initial Token Offering”) • This has the effect of comparing token distributions to IPOs (“Initial Public Offerings”), which benefits the hype-cycle but is detrimental to good-faith technologists building decentalized projects • Such technologists prefer the term “Token Launches” as there is no regulatory consensus that tokens are securities, currencies, commodities, assets or instruments, and many tokens are designed specifically to not invoke US securities laws • Google trends shows that the terms ICO and Crypto have experienced the largest popularity gains with the rise of token launches on the Ethereum blockchain, while the search term “Token Launch” or “Token Offering” is not widely used • We are resigned to use the term ICO as a shortcut, without any normative meaning as to the status of the tokens themselves
Jul12 Jan13 Jul13 Jan14 Jul14 Jan15 Jul15 Jan16 Jul16 Jan17
Ethereum
Source: Autonomous NEXT, Google Search Trends
Altcoin
Crypto
Token
ICO
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Executive Summary (1/2) • A new funding mechanism has been slowly coming to mainstream awareness that leverages the power of decentralized technology – –
Over $1.2 billion raised through these mechanisms in the first half of 2017, far outstripping venture capital investment into Blockchain and Bitcoin firms; approximately 50% of 2017 ICO capital raised in last 30 days Capital is often contributed in the form of Bitcoin (“BTC”) or Ethereum (“ETH”)
• These offerings are akin to sale of a future money supply or a platform utility enabler, rather than a sale of Securities – – –
Unlike the sale of equities in a private venture investment or in an Initial Public Offering, the object sold is a digital token or coin that is both scarce and validated based on advanced cryptography techniques The offerings are issued by collections of people that may or may not be formally organized as a legal entity Global regulation has not come to agreement about these offerings, with certain jurisdictions treating them as assets, commodities or currencies, and other jurisdictions split over which tokens are securities
• They must be offered on a Distributed Ledger and are fully digital, with most tokens designed and sold using the protocols of public smart-contract technology called Ethereum – – – –
Ethereum is the preferred platform of choice for issuing smart contract tokens using the ERC20 standard Tokens can be used as a medium of exchange and can be a replica of Bitcoin with philosophical differences (e.g., privacy, speed, supply) or have functional utility within a technologically advanced system Features of tokens can be designed to make them more like (a) an investment / security or (b) more functional; best practices for launches are being developed by leaders in the ecosystem (e.g. Coin Center) Some ICOs launch with developed products and roadmaps for utilizing proceeds, while others are raising money without a developed product aiming to leverage speculation
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Executive Summary (2/2) • The Crypto Economy is growing outside of traditional venues – this has happened before with video game gold farming and virtual economies, but not on such a global scale – – –
While BTC is the first digital currency to go mainstream, it is not the first digital currency or virtual economy Virtual economies with real economic value have evolved within video games such as World of Warcraft, Eve Online, and Second Life. The scale of new technology is orders of magnitude greater than prior iterations. The culture of the early Internet is directly connected to ICOs and investor personalities in the ecosystem
• Speculation and volatility across the Crypto Economy are rampant, and many participants are aware of both fraudulent practices and a growing bubble fuelled by Bitcoin whales – – –
The marketcap of BTC has increased from $10 billion at end of 2016 to over $40 billion halfway through 2017 Demand is driven by (1) entry of mainstream investors, (2) enterprise efforts in the financial industry like Enterprise Ethereum, and (3) movement of savings into digital currency in the developing world Unfortunately, many ICOs are fraudulent and intended to take advantage of excitement in the ecosystem by leveraging social media for promotion and a lack of enforceable consumer protection, raising legitimate regulatory concerns and attempts by select market participants to self-regulate
• Yet, underneath the turbulent waters are seeds for a massive transformation of the real world and we should learn from prior examples of economic phase shifts – – –
While many of the tech companies of the first Tech bubble in the late 1990s have disappeared, winners like Amazon and Netflix have experienced large capital gains and monopolization of their sectors While most cryptocurrencies have not been successful, BTC and ETH have experienced large capital gains and growing adoption, signalling an underlying structural shift that incumbents should embrace Investment into tokens allows economic participation at the protocol layer of a next-generation internet
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Introduction to Initial Coin Offerings
Getting started with ICOs • Initial Coin Offerings / Token Launches are an emergent phenomenon of Blockchain technology and virtual communities – –
A group of technologists, often that are well-known in the cryptocurrency community (forums, Twitter, Reddit, Github), or that are part of a more institutional setting, decide to work on a project They author a white paper that explains the technical and business dimensions of a project. Best practices include explaining how the technology works, the role of the token and its source of value, and mechanisms for issuing tokens and accessing raised funds, increasingly supported by independent audits
• ICOs combine the trends of (1) crowdfunding powered by the virality of Internet marketing, and (2) exponential technology growth through adoption within a tech-forward network – – – –
Tokens are sold to a global crowd whose main commonality is technological literacy; there is generally no requirement to be an accredited investor or live in a particular geography Often, the real-world adoption of the project undergoing the ICO correlates with the value of the tokens, and in many cases the community that buys the tokens will also utilitize them (e.g., decentralized cloud storage) -Consider the virtual currency of video games, where in-game gold has value only for internal use by players Yet in many cases, participants purchase tokens primarily for speculation and capital gains
• To participate in an ICO and own a token requires specialized software and knowledge –
–
Ownership is determined by holding the digital access keys allowing transfer or use of the token, or account with an intermediary that holds the token for the owner. Given the state of the ecosystem, some participants essentially hide cash under a mattress, by writing keys on a piece of paper and putting it into a physical safe. A large niche has grown around providing all types of wallets -- hardware, software and otherwise -- in which tokens or coins can be stored, but third parties can be hacked and cannot reverse decentralized transactions
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Token Value is derived from two primary sources today: Functional and Speculative Imagine there are plans to open a new Casino, and for funding, the Casino sells its own plastic chips before opening, in anticipation of customers using these chips and creating economic value.
• The functional value is that which is derived from the use of the token itself • In Bitcoin, the utility value is replacing sovereign fiat and enabling payments as a scarce self-regulating digital currency • In Ethereum, the utility value is the facilitation of a smart-contract ecosystem that powers the global economy, from finance to the Internet of Things • Recent ICOs have defined very specific utility values for tokens, which fuel their ecosystem
Source: Autonomous NEXT
+
Further, the buyers start trading these chips based on the expected value of the casino, how well attended it will be, and whether other chip holders are trading.
• The speculative value is the value a trader of the token derives from trading it on an exchange, relative to others • This can be a positive development for the ecosystem as it draws validating capital, which can then be invested in real projects • If tokens are issued primarily for speculation, this raises regulatory issues
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Generally speaking, buying a Token is different from buying a Stock … Investing in Stocks Founders
labor
Outside Investors
cash
ownership
ownership
Investing in Tokens Founders
economic reward
labor
ownership
Operating Organization generation of economic activity
Outside Investors cash
economic reward issue
Products and Services Fiat Money Supply Company Utilities and Assets • Investors spend cash for an ownership of the operating company that generates economic activity • Products and services rely on external money supply to function in an economy • Company utilities, like money transfer technology between bank departments, is not monetized Source: Autonomous NEXT
(tokens are generally , though not always, liquid)
Operating Organization generation of economic activity
Ownership
own
Products and Services Functional Utilities or Proprietary Money Supply • Investors spend cash for an ownership percentage of the functional utilities or proprietary money supply • Operating organizations have a range of control over token supply, depending on issuance rules • While best practice is to have partly constructed the network prior to ICO, it is not a requirement
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... but Tokens can be designed to have aspects of Securities, and securities can be tokenized Consensys, Coinbase, Coin Center, Union Square Ventures and the law firm Debevoise propose a framework that separates Blockchain tokens with “investment interests” from those with merely “rights” (i.e., functional features) for the purpose of US Securities Law under SEC. v. Howey (1946). The test is later discussed in the section on Investment Structure Considerations, but we quote from the paper here in regards to features that can make tokens more or less like investments.
Investment interest features • Ownership interest in a legal entity, including a general partnership or an equity interest • Share of profits and/or losses, or assets and/or liabilities
Merely functional features / rights • Rights to program, develop or create features for the system or to “mine” things that are embedded in the system • Rights to access or license the system
• Status as a creditor or lender
• Rights to charge a toll for such access or license
• Claim in bankruptcy as equity interest holder or creditor
• Rights to contribute labor or effort to the system
• Holder of a repayment obligation from the system or the legal entity issuer of the Blockchain Token
• Rights to sell the products of the system
• A feature allowing the holder to convert a nonsecurity Blockchain Token into a Blockchain Token or instrument with one or more investment interests, or granting the holder an option to purchase one or more investment interests
Source: Debevoise, Consensys, Coinbase, Coin Center, Union Square Ventures
• Rights to use the system and its outputs • Rights to vote on additions to or deletions from the system in terms of features and functionality
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Supply & Demand dynamics, and associated limitations, shape market behavior and valuation run-ups Pricing Issues • Normally, the price of tokens during an ICO would be determined by supply and demand, but current demand is insensitive to price • To avoid irrational outcomes, either supply or demand must be constrained - If supply is fixed at a total value for the offering (e.g., $10MM), there is the question of determining allocations. An example would be the BAT ICO, which raised $35MM in 30 seconds, with many investors locked out - If all demand is allowed to pour in, then bubble outcomes are created, with hundreds of USD equivalent poured into unproven projects at what should be a Seed stage, which creates the impression of irresponsibility and greed • Developers have been experimenting with Dutch auctions, constrained timing mechanisms, and pricing floors/ceilings as solutions to augment distribution and pricing
Source: Autonomous NEXT, Vitalik Buterin
Aggregate Supply / Demand in Digital Tokens Supply
Price in $
Clearing Price
A self-imposed good-faith price ceiling (i.e., not raising $1B for a brand new project) creates a gap between supply and demand. In current environment, this selfrestriction is weakening.
Price Ceiling
Actual Price
Demand Available Quant
Desired Quant
Token Utility Value
• Demand is likely 5-10% of all cryptocurrency supply, or about $5B of value, corresponding to the speculative part of an asset allocation looking for diversification • Supply of all feasible useful tokens today is constrained by the development talent available to build projects
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While the type of risk in ICOs is similar to other early stage projects, judging quality is different from venture capital … Venture
ICO
Kickstarter
Team
• Mix of technology and business leaders
• Track record in cryptocurrency community • Highly technical
• Most important element of project; proven capacity to deliver on similar projects
Market
• Large $1B+ addressable market, potential pivots
• Predefined large technical problem • Proximity to infrastructure
• Predefined product problem, no pivots
Traction
• MVP or initial committed customers
• Prior technical projects publicly shared on Github
• Team assures customers on ability to deliver
Competition
• Structure of industry meaningful for ability to monopolize position
• Many blue-ocean opportunities, need only vague market strategy
• Not relevant as demand is defined by raise
Economics & Distribution
• Business model exists and works on margin
• Vague indication tends to be sufficient
• Not relevant as demand is defined by raise
Legal Status
• Well defined C-Corp or SAFE investments
• Wide range of legality, from CoinList to frauds and scams
• Well defined contracts that are automatically papered and actioned
Presentation
• PowerPoint, Demo • Relationship driven
• Tech whitepaper, video • Highly social media
• Video, written narrative • Highly social media
Source: Autonomous NEXT
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... and best practices are only beginning to be defined ICO Best Practices (Consensys, Coinbase, Coin Center, USV) Detailed White Paper
• Clear technical descriptions of what is being built
• Explanation of what the token does, why it should exist, and how they are issued
Clear Development Roadmap
• Project is divided into stages, for which there is an allocation budget • Funds are escrowed and released upon progress against goals
• Constituents receive transparent communication and reporting on progress, both financial and development
Open Source and Published Code
• Code is open source and team contributes to the community, using well-known standards
• Code that is private or overly centralized control may signal ulterior motives
Clear and Fair Pricing in the Sale
• Amount being raised is clearly defined and ICO period ends upon success
• Raising far more than project development cost can corrupt incentives
Developer Percentage
• Developers are founders, own a percentage of tokens, and interests are aligned
• Ownership percentage is consistent with best-practices in other early stage investing
Independent Review
• Trusted technical experts vet the white paper and its claims • Security audits and bug bounties for code
• ICO rating and diligence agencies evaluate the offering process
Good Faith Marketing Approach
• Promotions focus on the function of the network and the token as a clear utility
• Token is not marketed as an investment with high speculative upside
Source: Debevoise, Consensys, Coinbase, Coin Center, Union Square Ventures
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ICO Market
Initial Coin Offerings started to gain importance in 2016, with the potential to capture more crowdfunding interest Notable Initial Coin Offerings ($ million) 2014 $26 2015 $14
Ethereum MaidSafeCoin Storj
Lisk Augur NeuCoin ZiftrCOIN Factom Synereo
Crowdfunding Volume, Global ($ billions, 2015) $18.9
$7.0 $0.5 $6.2 $5.3
Until 2017, all the token launches taken together were less than 1% of global crowdfunding activity, suggesting meaningful opportunity
$0.9 $0.9 $0.5 $0.1
Royalty, $0.4
$150+
2016 $222
The DAO Waves ICONOMI Golem SingularDTV DigixDAO FirstBlood Synereo Decent Antshares ETCWin Komodo Incent Plutus Stratis Golos
$16.0 $10.5
$8.6 $7.5 $5.5 $5.5 $4.7 $4.1 $4.0 $1.3 $1.1 $1.1 $1.0 $0.5 $0.5
Source: Autonomous NEXT analysis, Smith & Crown, ICO-list, Alex Felix, Blockchain Angels
Hybrid, $0.8
ICOs, $0.3
Equity, $2.5 Reward, $2.7
Donation, $2.9
$34B
P2P, $25.1
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2017 YTD ICOs have not disappointed, with over 1.2 billion of USD equivalent raised for over 50 projects Notable Initial Coin Offerings ($ million, log scale) 208 200 153
Number of Token Sales
56
Total Proceeds ($MM) 95
80
53 42
35 33 30 29
25 22
19 17 16 15 14 14 13 12 12 12 12
$1,265.9
Average Proceeds ($MM)
$22.6
Median Proceeds ($MM)
$5.5
10 7.7 7.1
5.6 5.4 5.2 5.1
5.0 4.7 4.6 4.5
3.8 3.8 3.4
3.1 2.9 2.8
2.7 2.5
2.1 2.0 2.0
1.6
1.4 1.3 1.3
1.1 1.1
1.0
0.6
0.6
0.1
Source: Autonomous NEXT analysis, Smith & Crown, ICO Tracker, ICO List, Finance Magnates, Newsbtc Note: Some ICOs are still in progress as of the publishing date, and the value of tokens fluctuates due to exchange rates
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Offerings are shifting from core technology to use cases like markets, investment products, media and identity ICOs by Category ($ millions) 26
14
222 16.8
194.2
25.8 133.6
166.0 101.9
6.2
513.1 2.1 8.6 1.8
2014
2015
Source: Autonomous NEXT analysis
16.6 2.4 2016
$200.0
BANCOR
5.3
18.9
$208.0
EOS.IO
147.3 77.9
0.5
Tezos
1,266
5.5 4.0
7.5
Top 2017 ICOs by Category ($ millions)
36.5 2017 YTD
$153.0
Status
Media & Social
$95.0
TenX MobileGo
SONM Gaming & Gambling Basic Attention Token 7.5 Internet of Things & Civic 5.3 Storj People Polybius Finance: Markets Aragon Æternity Finance: Investments OpenANX 0.5 Cosmos Network Finance: Banking & Qtum Payments Giga Watt Cloud Mysterium Network Nimiq 18.9 6.2 Core Tech TokenCard Dao.Casino Cryptocurrency Gnosis IEX.EC ABTcoin Blockchain Capital Fund III 1.8 TaaS ZrCoin 2014 Matchpool 2015
$80.0
16.8 $53.3 5.5 $42.0 4.0 $35.0 $33.0 $30.0 $28.9 $24.8 $22.4 $18.8 $16.8 166.0 $15.6 $14.6 $14.1 $13.6 $12.7 $12.3 $12.3 $12.1 $11.8 2.1 $10.0 8.6 $7.7 16.6 $7.1 2.4 $5.6 2016
147.3 77.9
Media & Social
Gaming & Gambling 194.2
25.8 133.6
101.9
Internet of Things & People Finance: Markets
Finance: Investments Finance: Banking & Payments Cloud
513.1
Core Tech Cryptocurrency
36.5 2017 YTD
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Example 1: The DAO (Financial Investments) Overview • The DAO (Decentralised Autonomous Organisation) is a smart contract system that was designed to function as a community managed venture fund, without the need of any employees and was implemented on the Ethereum blockchain.
Year
Tokens Issued
Amount
2016
1B+
$150 million
Estimated Market Capitalization ($mm)
• The ICO ran from 1st May – 28th May 2016, after which it issued 1,153,816,599 tokens at an exchange rate of 100 tokens per Ether. • All funds raised were in the form of Ethers. • The DAO was the largest ICO of its time but ultimately, a $59 Million system hack resulted in it’s downfall. A ‘hard fork’ was used to retrieve the stolen funds and the DAO ceased to function. • The idea has resurfaced as Hong Coin, ICONOMI and TaaS. All differ in that they still have a set of professional investors aiding in fund allocation.
Source: Autonomous NEXT, Coinmarketcap (as of June 21, 2017)
• Exceeded expectations becoming the largest ICO at the time, although market cap fell dramatically when the system was hacked and was shut down shortly afterwards, leading the market capitalisation to fall to 0.
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Example 1: The DAO (Financial Investments) Discussion • The DAO has no owner. Funds generated in the ICO and Creation period are sent from users to a smart contract address that creates DAO tokens and sends them back to the user address.
• The Smart Contract system allowed companies to make proposals for funding. These would be white-listed by the DAO ‘curators’ and the token holders would vote on proposals. • Rather than having an owner, manager and analysts, in its place was just code with consensus mechanisms on particular investments. • This in theory would make the DAO automatic, unbiased and incorruptible, whilst processing the wants of investors. • A developer figured out how to “double-spend” money in the DAO and kept recursively withdrawing millions. In the end, the entire Ethereum chain was “forked”, transactions were reversed, and this became a huge split in the community. Source: Autonomous NEXT, DAO
• If investors found an accepted proposal to be damaging, they could get back the Ether they sent to the DAO. This was known as the ‘split function’. • The ICO was considered risk-free where users could recover their invested Ether by splitting their tokens on a scale of 1 Ether to 100 DAO and move them off the DAO chain.
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Example 2: The SONM (Cloud Computing) Overview • SONM is a decentralised fog supercomputer operating on the Ethereum network. It plans to utilise spare computational power to aid networks that don’t have sufficient power. • Buyers of computer power are provided a more cost-efficient solution than conventional cloud providers by combining spare capacity on a pool of devices (IoT) with cloud servers. This is known as ‘fog’ computing. • The ICO raised $42 million by over 4 days. All investments were to be made in Ethers only. • Most notable competitors on the Ethereum network are Golem, Elastic and iEx.ec, all of whom operate on a similar business model. • No additional tokens released into the system, resultantly replacing hash-based cryptocurrency mining with the option to provide computational power instead.
Source: Autonomous NEXT, Cryptocompare
Year
Tokens Issued
Amount
2017
166
$42
million
million
Estimated Market Capitalization ($mm) 50
40 30 20 10
0 14 Jun
16 Jun
18 Jun
20 Jun
22 Jun
24 Jun
26 Jun
28 Jun
• Price captures Ethereum and BTC volatility
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Example 2: The SONM (Cloud Computing) Discussion • SONM connects buyers and workers through a decentralised open market place that profits the users primarily. • Within the currency, the aim is to replace traditional proof-of-work mining with fog computing to reduce costs, thus providing a ‘fresh start’ to solo miners. • Passive income is offered to users who provide their spare computational resources for rent through SONM. • Fog computing enables completion of previously incomputable tasks, such as: Complex scientific projects, site hosting, game servers, neural network projects and rendering video and CGI. SONM allows for all computing devices to be used for adding computational power into the network, including GPU, CPU, Playstations, smartphones, and others.
Source: Autonomous NEXT, SONM white paper
• Cloud technologies are highly monopolised at present, fog computing claims to provide cheaper computational power at scale.
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Example 3: Storj (Cloud Storage) Overview • Storj is a decentralised cloud storage network that was built initially as a decentralised app on top of the Counterparty network. • Storj issued up to 25% of the 500 million total tokens in its second ICO on the June 21st , 2017.
Year
Tokens Issued
Latest Amount
2015 & 2017
